Salary vs. Dividends: What’s Best for Canadian Small Business Owners?
As a small business owner in Canada, one of the key financial decisions you’ll face is how to pay yourself: salary or dividends? Both options have advantages and drawbacks, and the right choice depends on factors like tax efficiency, retirement planning, and business profitability. Let’s break down the differences and help you determine the best approach for your situation.
Understanding Salary and Dividends
Salary
A salary is a form of employment income paid by your corporation to you as an employee. It is subject to Canada Pension Plan (CPP) contributions, personal income tax, and potential Employment Insurance (EI) premiums (if applicable). Your business can deduct your salary as an expense, reducing its taxable income.
Dividends
Dividends are payments made to shareholders from the company’s after-tax profits. Since dividends are not considered employment income, they are taxed differently and do not require CPP contributions. However, the corporation does not get a deduction for dividends paid.
Comparing Salary and Dividends
1. Tax Considerations
Salary is subject to personal income tax at progressive rates. Since it reduces corporate income, it can lower the business’s overall tax burden.
Dividends are taxed at a lower personal rate due to the dividend tax credit, which accounts for corporate taxes already paid.
Integration Theory: Canada’s tax system is designed so that earning money through salary or dividends should result in similar overall tax liability, but differences arise due to tax brackets and credits.
2. CPP Contributions
With a salary, you and your corporation must contribute to CPP. In 2024, the combined employer-employee CPP contribution is up to $7,735. This helps build retirement income but is an added cost.
Dividends do not require CPP contributions, allowing for greater take-home pay but no CPP benefits in retirement.
3. RRSP and TFSA Contributions
Salary qualifies as earned income, allowing you to contribute to an RRSP (Registered Retirement Savings Plan), which defers taxes on investment gains.
Dividends do not count as earned income, limiting RRSP contribution room. However, you can still contribute to a TFSA (Tax-Free Savings Account).
4. Corporate Tax Considerations
Salary reduces taxable corporate income, which can be beneficial if your business is in a higher tax bracket.
Dividends are paid from after-tax corporate profits. If your business qualifies for the small business tax rate (9% federally in 2024), it may be advantageous to leave more earnings in the company.
5. Cash Flow Flexibility
Salary must be paid regularly, while dividends offer more flexibility—you can issue them based on company performance.
If your business has unpredictable revenue, dividends allow you to avoid fixed payroll obligations.
6. Record-Keeping and Administration
Salary requires payroll setup, deductions, remittances to the CRA, and T4 reporting.
Dividends require a T5 slip but have fewer administrative burdens.
Hybrid Approach: Best of Both Worlds?
For many small business owners, a combination of salary and dividends is the most tax-efficient strategy. A typical approach is to pay yourself enough salary to maximize CPP benefits, RRSP contributions, and personal deductions, while taking additional income as dividends to benefit from lower tax rates.
Example Hybrid Strategy:
Take a salary up to the basic personal amount ($15,000 in 2024) tax-free.
Earn enough salary to maximize CPP contributions and create RRSP room.
Pay the remaining income as dividends for tax efficiency.
Which Option is Best for You?
Your ideal choice depends on:
Income level: Higher incomes may benefit more from dividends, while moderate earners might prefer salary for RRSP and CPP benefits.
Retirement planning: If you value CPP and RRSP contributions, salary is important.
Corporate profits: If your business has high taxable income, salary can reduce corporate tax.
Cash flow needs: If you prefer a stable income, salary is better; if you want flexibility, dividends work well.
Final Thoughts
Taking salary vs. dividends is a strategic decision that requires careful planning. It’s often best to consult with an accountant to determine the most tax-efficient approach for your unique situation. A well-balanced mix of salary and dividends can help maximize your wealth while ensuring long-term financial stability.
